Principle residence sale rules to live by

Title issue could jeopardize tax exemption
By: Robert J. Bruss: Inman News
Here are some additional issues that frequently arise regarding principal residence sales:

1 – Principal residence sale in the year of a spouse's death. IRC 121(b)(2) says the $500,000 principal residence sale exclusion is available for the sale of the marital home if the sale closes in the tax year of a spouse's death. Although the IRS considered extending this time limit beyond the year of a spouse's death, it found there is no authority to do so without the approval of Congress. The tax reason is that a surviving spouse can only file a joint tax return with the deceased spouse for the tax year of that spouse's death, but not in future tax years after that.

However, this is not such a "big deal," as many surviving spouses believe. If the surviving spouse inherits the deceased spouse's half of the home, the surviving spouse receives a new basis on that inherited 50 percent "stepped-up" to market value as of the date of the spouse's death. If the principal residence is in a community property state, the surviving spouse usually receives a new stepped-up basis on 100 percent of the home's entire market value on the date of death.

This stepped-up basis for the deceased spouse's interest in the home usually is far more important than the $500,000 principal residence sale tax exemption, which is available only in the year of death when a joint income tax return can still be filed.

The only time the surviving spouse is usually hurt financially occurs if title to the residence was held in the name of the surviving spouse alone so there was nothing to inherit from the deceased spouse. Then the surviving spouse does not receive a new stepped-up basis because he or she already held full title.

2 – Holding title in a living trust doesn't change eligibility for the $250,000/$500,000 exemption. When title to a principal residence is held in a trust for the benefit of the trustor, such as a living trust that avoids probate costs and delays, the method of holding title is disregarded for purposes of IRC 121 tax exemptions. "The sale by the trust will be treated for federal income tax purposes as if made by the grantor," IRS regulations explain.

3 – Sale of a partial interest in a principal residence won't increase the exemption. At the time a qualified principal residence owner sells a partial interest in the home, such as a sale to a son or daughter, that sale can qualify for the $250,000 or $500,000 exemption.

But this is not a tax loophole to allow the seller one exemption for a partial sale now and another exemption in the future when selling another partial interest. The IRS regulations clearly state that the maximum $250,000/$500,000 exemptions cannot be exceeded when selling partial interests in the seller's principal residence.

4 – Exempt principal residence sales need not be reported to the IRS. The IRS regulations state: "Reporting of an excluded gain is unnecessary and would be unduly burdensome for taxpayers."

However, if your principal residence sale is partially taxable, such as when your capital gain exceeds the $250,000 or $500,000 exemption, your home sale should be reported on Schedule D of your federal income tax returns, clearly showing the exclusion amount.

SUMMARY: The $250,000 and $500,000 principal residence sale capital gain exclusions are major tax benefits for home sellers who understand how to maximize their exemptions. More details can be found in the IRS Regulations at IR-2002-142, available on the IRS Web site at www.irs.gov/newsroom with a link to the IR regulations as published in the Federal Register.